Along any of the mentioned payoff curves, the slope of the line tangent to the curve at a price is the options Delta (another Greek letter). By understanding GEX and LVR, LPs can try to predict how to best manage their positions. Let me give you an example: let's say someone wants to sell a call option on SPY with 45 DTE and strike price of 480 for whatever reason (maybe that person owns some SPY stock and wants to increase the yield through a covered call strategy or maybe that person is long some put options and wants to partially cover the cost of that hedge or that person just want to sell that call option because the planets are aligned). By understanding GEX and LVR, LPs can try to predict how to best manage their positions. The key question is: do the MMs need to BUY or need to SELL?? Set the variable "filename" equal to the file path to that download on your local drive. SPX (GEX) Dark Liquidity Gamma Exposure (Market Makers) Wish you all the best. A low gamma value translates to low volatility of an option position 's directional risk exposure. In this paper, Squeeze Metrics did an amazing job explaining what Gamma Exposure is and its implication in the hedging dynamics of any Market Maker (if you want to read this paper, use the following link and you will be able to download it). This is a very interesting insight Now you can measure the level of "strength" a MM has and how it can "influence" the price of the underlying asset (remember: we are not talking about market manipulation we are talking about how many securities the MMs need to buy or sell to be fully hedge.. but, sometimes that number is so big that, at the end, they affect the price -, If you want to have access to the code that generates all this analysis (and more), use the following. The total gross gamma outstanding is $8 billion, meaning that market makers need to trade approximately $8 billion worth of $SPX for a 1% move in the index. By running again the previous script, we get the following values for all the greeks: Now the delta of this position is 0.30. As prices rise, the market maker must add positive exposure thereby adding "fuel to the fire" by buying more. Gamma exposure is an estimated measure of the overall option market makers' (aka option dealers') exposure to the options Greek known as gamma. Frequently leaving the market perplexed and confused as to what just happened. We discuss how market designers, crypto traders, LPs and quants can build positions to reduce the GEX loss vector. Disclaimer: in this blog you will only see personal opinions about investing. All in all gamma flip or volatility trigger points are derived from an estimation how market makers are . When the street is long gamma, that means option market makers net-net bought options. It is a matter of applying Itos lemma, as in the proof of Theorem 1 of the paper by Milionis et al., to see that this integral from the Monotonic Payoffs paper is LVR. For some prices S, the curves may have larger curvature, which means the magnitude of is larger. So, if a market maker offsets this upside risk with Gamma Hedge by adding call options, or the underlying shares to the portfolio. If an MM was not active, a movement in the price for the underlying would lead to a nonzero delta which is not ideal. As such, MMs are found on both sides of the market, creating bids and offers. Furthermore, the original purpose of. A MM's business is not related to expeculation; is related to creating a market and earning a fee for that (they don't want to earn money assuming any directional risk). Now let's say the price of the SPY goes up by $1 (to 461$). Risk Transfer in the Supply Chain of Options Markets In absence of any risk management, a dealer pro t pro le is potentially very volatile and non-linear. Gamma and Gamma Exposure (GEX) are becoming increasingly important forces in today's market, and have the potential to become one of the most important non-fundamental flows in equity markets. Q&A -- Here, though, we're peeling away any and every layer of complexity to the computation and revealing a simple ratio: The gamma of all call open interest to the gamma of all put open interest. Wow, Wow, Wow just one sec +1 for calls, -1 for puts???? The issue though is that squeeze metrics calculates GEX from the open interest, assuming that market makers buy calls and write puts.. which is probably ok for the names like AAPL or AMZN but a no-go for the names like GME or AMC. are agreements between two parties on selling or buying assets for a specific price on a certain date. 0 subscriptions will be displayed on your profile (edit). Notice the term in the integrand g(S). A tag already exists with the provided branch name. At least that way, well recognize when it happens, and well be prepared. A MM's business is not related to expeculation; is related to, So, the moment that person sold that option a MM bought it; and for the MM to be "free" of directional risk it needs to take the delta of that option, multiply it by the multiplier of the underlying (in this case it's 100 shares of SPY per option contract) to know how many shares of SPY needs to, Now the delta of this position is 0.30. So, the above formulas are going to be modified as follows: GEX (for call options) = +1 * Gamma * Open Interest * Multiplier * Spot Price ^ 2 * 1%, GEX (for put options) = -1 * Gamma * Open Interest * Multiplier * Spot Price ^ 2 * 1%. The absolute value of the GEX index is simply the number of shares that will be bought or sold to push . By entering and using this website, you acknowledge that you have read and understand our Terms of Service, our Cookie Policy and our Privacy Policy. A big factor in market movements is the market makers buying and selling options from and to the traders. Given that an LP experiences losses due to the inability to hedge GEX actively, it is of great interest to design LP positions that allow for active liquidity management. "Total Market Gamma" is often the metric that most people are familiar with. Feel free to leave us your email and we'll let you know if a place becomes available. The amount of delta-hedging needed is mainly dependent on this thing called gamma. So, in this post I want to explain what is gamma exposure (GEX) using a simpler and more straightforward approach (step-by-step formulas, as well as a script that I have developed in Rstudio so that you can analyze, at any time, the current GEX level of any ticker - however, I must warn you that the approach I'll explain works better for indexes rather than single names; and the guilty for this is the Volatility Smile/Smirk but we'll come back to this later in this post. I filtered for options with 75%-125% moneyness on SPX, calculated the aggregate $-gamma per contract using unitGamma * contractMultiplier * underlyingPrice * openInterest (example: 0.0713 * 100 * 2843.49 * 86212 = 1'747'869'304). The preceding logic tells us that is the rate of change in ! Note that W is defined for any price process. For example, at the end of this month a lot of Negative Gamma (basically due to a very big trade of JPM that is currently ATM) will be remove from the market and that will have, or I think we can expect, a positive impact in terms of volatility. . So, in this case Gamma will be 0.01. then define Loss-Versus-Holding (LVH), which is the exact definition of impermanent loss: For LPs, we see that LVH is given by taking x_s=x_0, and they show that LVH has variation bounded below by LVR. In this scenario, delta-hedging flows move in the same direction as the market, potentially amplifying the price action. In the paper Automated Market Making and Loss-Versus-Rebalancing (preprint), the authors Milionis et al. Succinctly, if V(S) is the value of some position for price S, then =V and =V=. The information on this site and in its related blog, email and newsletters, is not intended to be, nor does it constitute, investment advice or recommendations. known market volatility, the current price and LP GEX at that price determine LVR (or LVH). The nonlinear payoff allows traders to make directional bets and hedge unfavorable price movements. So, the GEX interpreation in this condition is as follows: MMs will buy (sell) GEX dollar amount of SPX per 1% price increase (decrease). The call and put both have positive , and the covered call has negative . More truthfully, they define a general measure of, (LVR), which allows the LP to choose their own benchmark for portfolio balancing. As a result, they have to buy additional securities when prices are rising, and sell when prices are falling to help to ensure their positions are neutral even as the value of the underlying changes. The authors Angeris et al. This additional buying can become a tsunami of positive price action. Pick a point on one of the curves. How To Calculate Gamma Exposure and Zero Gamma Level. Calculates estimate of market maker gamma exposure derived from S&P 500 index options - GitHub - pericoma0147/SPX-Gamma-Exposure: Calculates estimate of market . Use tab to navigate through the menu items. Gamma shows the potential amount of delta-hedging activity by the market makers. Its a source of one of the most significant structural flows in the equity markets. Finally, in a different post, I will talk about Vanna Exposure (VEX), GEX's bipolar cousin, and how we should factor in that exposure into our market analysis and decision making process. So long as the bid for the option fits the set bid/ask spread provided by the MM, the MM sells the option to the trader. Learn more about hedging strategies . Suppose we assume the same price process as Milionis et al. So, for a MM to be "free" of any directional risk it has to hedge their position everytime someone wants to buy or sell an option. Quarterly third Friday options also have an added benefit of $SPX futures expiring on the same date. Click the link we sent to , or click here to sign in. No worries, the reason behind that square is the following: If Gamma * Open Interest * Multiplier * Spot price will give me the GEX for 1$ move change in price of the underlying asset (mainly because gamma is the change of delta per 1$ price move in the underlying asset); how much will it be the GEX if I have Price * 1% move?? If, e.g., a market-maker sells a single, 20-delta put contract to an investor, he must then short-sell approximately 20 shares of the underlying stock* in order to (temporarily) neutralize the convexity eQect of the option's gains and losses. The Gamma Exposure of this position, at that strike, is 1 share times 461 or 461$ (assuming the total OI at that strike is only 1). What is Gamma Exposure and Why Should Equity Investors Care? Look at the payoff curves for a put, a call, and a covered call. Gamma Exposure for Liquidity Providers Leads to Loss-Versus-Rebalancing, This site requires JavaScript to run correctly. Well, the result is as follows: You will be able to tell if the current conditions can be better or worse in terms of volatility/GEX scenarios after this week or after this month simply by looking at how the GEX profile collapses or expands. The total gross gamma outstanding is $8 billion, meaning that market makers need to trade approximately $8 billion worth of $SPX for a 1% move in the index. mmmmm, perhaps). I suck at options, but still want to use them. Press question mark to learn the rest of the keyboard shortcuts. Lets explore how it impacts your business. Mainly, at any moment with. If GEX is negative, MMs will sell all dips and will buy all rallies removing liquidity from the system and adding volatility (as a destabilizing force). Your request has been submitted successfully. The information on this site, and in its related application software, presented in R - Python - Excel, this blog, email and newsletters is not intended to be, nor does it constitute, investment advice or recommendations. Options Fundamentals -- The results are: Let's focus our attention, right now, on Delta. However SPX-Gamma-Exposure build file is not available. Work fast with our official CLI. Follow me on Twitter (https://twitter.com/perfiliev) for more educational threads around stocks, options and other topics within the incredible world of financial markets. The inability to hedge GEX causes LPs to lose profits by Loss-Versus-Rebalancing (LVR). We will be in touch. One example is dAMMOp. In the above equation, note that is the market volatility and that V(S) is precisely the of the LPs position. The mechanism behind gamma exposure Market makers buy and sell options from and to traders and must hedge their market risk by buying or selling the underlying equities or futures, if they want to avoid going broke sooner or later. Any time 'gamma' is under 1.00, puts are . As we can see, there is a new term: Gamma Flip. In this case, their GEX varies from price to price and dictates the MMs choice to take on more longs or shorts. So, if the market is buying puts and selling calls, the MMs must be selling puts and buying calls (and this is why the MMs has positive gamma in their call positions and negative gamma in their put positions). In Traditional Finance (TradFi), Market Makers (MMs) constantly hedge their Gamma Exposure (GEX) to avoid losses. One example is, . After a handful of assumptions about the price process, the authors find that the, How can we think of this quantity? In a future post, Colin will discuss TradFi and DeFi MMs in more depth, as well as CFMM GEX and volatility from it. http://www.cboe.com/delayedquote/quote-table-download, "CBOE_Greeks" returns a plot of Black-Scholes option Greeks by option strike. LVR was hinted at in an earlier paper Replicating Monotonic Payoffs Without Oracles (preprint). In contrast, the put has negative . Calculates estimate of market maker gamma exposure derived from S&P 500 index options. Since these options are short-term and often have strike prices close to current market prices, their overall effect is to raise gamma in the market. So, the GEX interpreation in this condition is as follows: MMs will buy (sell) GEX dollar amount of SPX per 1% price decrease (increase). In this sense, LPs lose profit due to their inherent GEX and inability to actively hedge it. Since the convexity itself cannot be hedged away, the market-maker must commit to . The first one is where the Total Gamma Exposure blue line crosses the current spot red line. For example, when the benchmark is to HODL, meaning there is no rebalancing and we are comparing against the performance of buying and holding the underlying, the loss an LP experiences, IL. Calculates estimate of market maker gamma exposure derived from S&P 500 index options Dependencies: pandas, numpy, holidays, datetime, requests, py_vollib, pyVolLib (my helper file in this directory), matplotlib "TRTH_GEX" requires a pandas dataframe of output from Thomson Reuters's Tick History, listing end of day SPX option quotes. This point represents the current spot gamma exposure and occurs at around -$19Bn. SPX Gamma Exposure. Traditional insurance business typically uses diversification as a risk-management tool. When a stock is falling, market makers are highly motivated to sell the stock to hedge their exposure. Is there anything that can stop gamma and its evil plans? This is evident in the $SPX skew, which shows higher implied volatility for puts than calls. Therefore, during positive GEX conditions we can expect a positive (not strong) uptrend, a low volatility environment, and a contango in the term structure of the volatility. Pandas dataframe must contain "RIC", "Trade Date", "Open Interest", and "Implied Volatility" fields to calculate time series of estimated daily market maker gamma exposure, "CBOE_GEX" is the simplest to use. At the chosen point, the curvature (really, the second derivative) is referred to as the Greek letter Gamma .
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